Bank of America strategist Michael Hartnett has outlined four key factors contributing to the bank's cautious outlook on stocks.
First, higher Treasury yields remain a concern, with inflation continuing to exceed the Federal Reserve's 2% target, as evidenced by a 3.7% rise in the consumer price index in September and a 6.3% increase in the producer price index, marking the largest annual gain since 2022. Traders are anticipating a more than 77% likelihood of a 25 basis point rate hike by the Fed before the end of the year.
Hartnett suggests that the Fed may need to act aggressively to restore credibility, especially given that inflation has been above the target for 66 consecutive months. Second, elevated oil prices driven by conflicts in the Middle East and Ukraine are adding to economic uncertainty.
Third, there is a growing expectation that Democrats may gain control of Congress in the upcoming midterm elections, with Kalshi traders estimating a 90% chance of a Democratic majority in the House and a 63% chance in the Senate. Lastly, the performance of AI-related stocks has been disappointing, with concerns over excessive debt accumulation for AI infrastructure.
Notably, CoreWeave's stock has dropped over 22% this week, and the VanEck Semiconductor ETF has declined by 9%. In light of these factors, Hartnett recommends increasing exposure to 'peak yield' beneficiaries, such as small-cap stocks, REITs, and consumer discretionary stocks, which may perform better in the current environment